Valuation for Financial Reporting - CMA Ankur Pandey

4 Valuation for Financial ReportingTo highlight the universal appeal of these goals, in 2002 the FASB and IASBentered into a memorandum of understanding called the Norwalk Agreement. The twoboards committed to use their best efforts to make their existing financial reportingstandards fully compatible as soon as practicable and to coordinate their future workprograms to ensure that once achieved, compatibility is maintained.Proponents of fair value accounting in financial reporting say such accountingstandards make financial information more relevant and improve transparency ofcompanies to stakeholders. Historically, accounting information focused on presentinginformation based on the cost of acquiring assets and the expiration of those costs.This type of accounting measurement was largely relevant to investors and creditors inthe past, because in many instances one could reasonably assess the value of shares orquality of the collateralized assets based on the company’s book value. Exhibit 1.1shows that the price-to-book-value ratio of the Dow Jones Industrial Average (DJIA)stock index generally ranged from 1.0 to 2.0 between 1950 and 1990. By the 1990s,investors were, knowingly or unknowingly, increasingly placing substantial value onthe intangible assets of companies. As Exhibit 1.1 demonstrates, the price-to-bookvalueratio of the DJIA reached 8.2 in 2000, which reflects substantial value beingplaced on intangible (largely unbooked) assets by investors. Since then, this ratio hasdecreased, but it is still higher than it was in the past.Critics of fair value accounting claim that the measurements are too subjective, toocomplex, and unnecessarily increase volatility of earnings. Accountants and auditorsmake many of these criticisms, as do some managements. Despite these criticisms, theaccounting standard setters are moving toward fair value measurements to makefinancial reporting more relevant to users.One can classify the key parties in financial reporting as preparers, auditors, andusers. Preparers are primarily management of companies in possession and control ofthe underlying financial records. Auditors in the United States are certified publicaccountants (CPAs) 5 who are licensed by state government agencies, and perform9.08.07.06.05.04.03.02.01.00.0195019551960196519701975198019851990199520002005Exhibit 1.1 Price-to-Book Value Ratio of Dow Jones Industrial Average Stock Index 6